DSW 2011 Annual Report Download - page 34

Table of Contents
Critical Accounting Policies and Estimates
As discussed in Note 2 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-
K, the preparation of our
consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of commitments and contingencies at the date of the consolidated financial statements and reported amounts of
revenues and expenses during the reporting period. We base these estimates and judgments on our historical experience and other factors we believe to
be relevant, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. The process of determining significant estimates is fact-
specific and takes into account factors such as historical experience,
current and expected economic conditions, product mix, and in some cases, actuarial and appraisal techniques. We constantly re-
evaluate these
significant factors and make adjustments where facts and circumstances dictate.
While we believe that our historical experience and other factors considered provide a meaningful basis for the accounting policies applied in the
preparation of the consolidated financial statements, we cannot guarantee that our estimates and assumptions will be accurate. As the determination of
these estimates requires the exercise of judgment, actual results inevitably will differ from those estimates, and such differences may be material to our
consolidated financial statements.
We believe the following represent the most significant accounting policies, critical estimates and assumptions, among others, used in the
preparation of our consolidated financial statements:
Inherent in the calculation of inventories are certain significant management judgments and estimates, including setting the original
merchandise retail value, markdowns, and estimates of losses between physical inventory counts, or shrinkage, which combined with the
averaging process within the retail method, can significantly impact the ending inventory valuation at cost and the resulting gross profit. DSW
records a reduction to inventories and charge to cost of sales for shrinkage. Shrinkage is calculated as a percentage of sales from the last
physical inventory date. Estimates are based on both historical experience as well as recent physical inventory results. Physical inventory counts
are taken on an annual basis and have supported DSW's shrinkage estimates. If our estimate of shrinkage, on a cost basis, were to increase or
decrease 0.5% as a percentage of DSW Inc. sales, it would result in a decrease or increase of approximately $4.2 million to operating profit.
Our cost of sales includes the cost of merchandise, which includes markdowns and shrinkage. We also include in cost of sales additional
expenses associated with warehousing (including depreciation), distribution and store occupancy (excluding depreciation and including store
impairments). Prior to the Merger, RVI included these additional costs in operating expenses. Warehousing costs are comprised of labor,
benefits and other labor-related costs associated with the operations of the distribution and fulfillment centers. The non-
labor costs associated
with warehousing include rent, depreciation, insurance, utilities, maintenance and other operating costs that are passed to us from the landlord.
Distribution costs include the transportation of merchandise to the distribution and fulfillment centers, from the distribution center to our stores
and from the fulfillment center to the customer. Store occupancy costs include rent, utilities, repairs, maintenance, insurance, janitorial costs and
occupancy-
related taxes, which are primarily real estate taxes passed to us by our landlords. Our cost of sales critical accounting policy has been
updated from RVI's policy to DSW's historical policy.
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•
Revenue Recognition.
Revenues from merchandise sales are recognized upon customer receipt of merchandise, are net of returns through period
end, exclude sales tax and are not recognized until collectibility is reasonably assured. For sales through the dsw.com sales channel, we estimate
a time lag for shipments to record revenue when the customer receives the goods. We believe a one day change in our estimate would not
materially impact our revenue. Net sales also include revenue from shipping and handling while the related costs are included in cost of sales.
• Cost of Sales and Merchandise Inventories.
Merchandise inventories are stated at net realizable value, determined using the retail inventory
method. The retail method is widely used in the retail industry due to its practicality. Under the retail inventory method, the valuation of
inventories at cost and the resulting gross profits are calculated by applying a calculated cost to retail ratio to the retail value of inventories. The
cost of the inventory reflected on the balance sheet is decreased by charges to cost of sales at the time the retail value of the inventory is lowered
through the use of markdowns, which are reductions in prices due to customers' perception of value. Hence, earnings are negatively impacted as
the merchandise is marked down prior to sale. Markdowns establish a new cost basis for inventory. Changes in facts or circumstances do not
result in the reversal of previously recorded markdowns or an increase in the newly established cost basis. The markdown reserve requires
management to make assumptions regarding customer preferences, fashion trends and consumer demand.
•
Investments.
Our investments are valued using a market-
based approach using level 1 and 2 inputs. Our equity investment is recorded at cost
and reviewed for impairment using an income approach valuation model that uses level 3 inputs such as the financial condition of the entity. We
evaluate our investments for impairment and whether impairment is other-than-